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After all, said my London colleague in late August, its near-term fundamentals are hardly inspiring, including a current account deficit and equity market overvaluation. The price gains weÆve seen in Indian equities û at least since registering challenging valuation readings in late 2006 û might well be attributed to the ômadness of crowds,ö he declared.
And yet, a few days later, another view arrived from Dubai. My driver there, the ever-professional Rashid, called me in New York to remind me that heÆd be visiting his family in Kerala, India, from the end of September to the beginning of November. When I noted that his visit didnÆt entirely coincide with Ramadan, he explained that he needed extra time to work on building his small house.
What was the significance of this tiny piece of evidence of heightened economic activity? We propose that thereÆs a core issue missing from the debate about India as an investment target: the role of foreign-worker remittances. We refer to the money that skilled, semi-skilled, and unskilled workers send home to the subcontinent. This phenomenon provides a surprising degree of support for stories that too many global investors ignore because of their distant view of local market dynamics.
The remittance issue is not only relevant to India, but also to Pakistan, Sri Lanka, Bangladesh, and often-overlooked Nepal. ItÆs among the reasons why an asset allocation decision to ôbuy on any dipö may make sense region-wide, especially for the secular investor, whether public- or private equity-oriented.
South Asia: Global remittance leader
The World Bank estimates that India is the worldÆs single largest recipient of foreign-worker remittances, at $27 billion in 2006. Fold in the numbers for Pakistan and Bangladesh at approximately $6 billion each, Sri Lanka at almost $3 billion, and Nepal at nearly $2 billion, and we sum up one of the largest cross-border capital flows in the developing world.
Moreover, experts argue that recorded numbers here are wildly understated because they donÆt include transfers through informal channels, such as the hawala network of honor-system money brokers. Another common means of value transfer in this sphere, gold jewellery, is typically categorized as an import rather than a remittance. Countless residual benefits of these remittances arenÆt captured fully in government statistics, either, including effects such as likely improvements in financial system infrastructure.
Relative to the size of GDP within each regional economy, the remittance flows to India and Pakistan are comparatively small at 3% and 4%, respectively, based on recorded data. For perspective, however, the US military budget is of similar size relative to total US output. The figures for India and Pakistan also are in line with the data for Mexico, suggesting the numbers elsewhere on the subcontinent are truly burgeoning.
Dilip Ratha of the World Bank suggests that total remittances (both recorded and unrecorded) may be larger than official development assistance, foreign direct investment, or even private portfolio capital flows.
We know that remittances are counter-cyclical, help to finance education and health, and reduce poverty. But we donÆt entirely understand their overall impact on economic growth, in part because of the presumed debilitating role of emigration on the origin country. Ratha has suggested that remittance flows can be securitized, noting that banks in Egypt, Kazakhstan and Turkey have raised long-term financing this way.
A mechanism needs to be found to take advantage of the rising inflows of foreign-worker remittances across South Asia, which the World Bank estimates have risen 17% annually for the past five years û and that doesnÆt account for unofficial flows. These are not abstract notions; in Kerala alone, remittances are estimated to be seven times the size of the annual state budget.
Not all of South AsiaÆs remittances come from the Middle East, but the region is assuredly the dominant provider. The GCC nations may now be the worldÆs largest source of remittances. Back in 1990, in the wake of the economic boom supported by $22/barrel oil, Saudi Arabia was generating greater remittance outflows than the United States. With the oil price averaging $62 this year, itÆs fair to conclude that not just Saudi Arabia, but the overall GCC region is generating unprecedented volumes of remittances, including both recorded and unrecorded flows.
Economic and investment implications
Presumably many exited the game of speculating in emerging markets in the wake of the Asian currency crisis. Assuming that near-term volatility is manageable, we see at least two long-term economic implications of the remittance backdrop for portfolio investors. These further support the asset allocation play into the region.
In our view, these inflows support local economic activity and act as an antidote to higher oil prices.
The global verdict on the growth impact of remittances may be inconclusive, but the results are more readily determined in South Asia, given the sheer volume of inflows. In Pakistan, for one, recorded remittances of about $6 billion in 2006 were roughly twice the amount of money spent on public and private health care. If we fold in unrecorded remittances, the number may approach, if not exceed, the annual value of textile exports, the largest tradable sector, at about $11 billion. Impacts are realized both secularly through heightened investment and cyclically through increased consumption.
Traditionally, higher oil prices link with inflation and therefore higher interest rates, leading to reduced economic activity. Yet research on the topic indicates that remittances have an important multiplier effect on the recipient economy, in part through the implied extension of credit associated with such remittances. Accordingly, it is no foregone conclusion that higher oil prices will have a net drag on the region, although we must acknowledge that South Asia is heavily dependent on crude imports.
We highlight some specific investment ideas, which merit further analysis than the surface-scratching here:
Bolster the gold price. Remittance data is notoriously understated because recorded statistics fail to identify the ôhand carryö portion. This typically manifests itself in the hard business of gold jewelry throughout the Middle East. Dubai, of course, has one of the largest gold souks in the world. The actual gold trading volumes may be massive, driven in part by the perceived, if not real, high cost of electronic transfers. We think this may be an overlooked reason for the relatively close price movements between gold and oil over the past several years. Assuming robust oil prices, we argue this under-appreciated relationship may continue to be sustained.
Lend support to selected industrial sectors. Market specialists may be well-served by brushing off their earnings models and double-checking any assessment of consumer-oriented or financial stocks, especially of those companies that serve niche markets. WeÆre curious, for instance, about the potential for earnings contribution that roaming charges might hold for some local mobile service providers. Enterprises in household durables and related furnishings are also worth a second look. Certainly any financial institution with a growing remittance-service business merits further investigation. There may be a range of players here as price competitiveness in the wire transfer business suggests volume opportunities.
We like the once-a-cycle opportunity afforded by South Asia. We recognize that foreign-worker remittances serve as a key engine for activity on the subcontinent, and we believe these flows ought to command more attention.
Remittances are one (currently misunderstood) reason to buy the South Asian story on any near-term weakness. That fact that India, despite its fundamental challenges, held up as well as it did during the early stages of the subprime fallout suggests that many investors are prepared to argue the same.
Douglas Clark Johnson is CEO and chief investment strategist of Calyx Financial in New York.
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